Hulu booms, but its owners aren't wholly pleased

LOS ANGELES ---- Pioneering Internet television service Hulurecently celebrated its third anniversary in a fitting locale:under the roller coaster at the Santa Monica Pier.

Hulu has reached a dizzying level of popularity among users byoffering easy and free online access to episodes of hit TVprograms. But the site's soaring success has inducedstomach-churning paroxysms for its owners, Walt Disney Co., News
Corp. and NBC Universal.

Now the website faces changes that could curtail its trove of
offerings or require users to pay for episodes they watch for free.
Once hailed as the networks' solution in taming the Internet,
Hulu's stunning success is now undermining the very system it was
designed to protect, forcing the site's owners to reconsider what
Hulu should be.

"Technology is changing so fast, and, as a direct result, so is
consumers' behavior," said Jordan Levin, chief executive of the TV
and Internet studio Generate. "One of Hulu's problems was that it
accelerated changes in behavior faster than the companies were
prepared for."

As a result, Hulu's media owners ---- the corporate parents ofABC, Fox and NBC ---- are tussling with the site's entrepreneurialmanagers over opposing visions for the venture. The companiesoriginally crafted the service as a way to control onlinedistribution of their content. But by offering popular shows suchas "Glee" and "Modern Family" online at no charge, the mediacompanies fear they may be encouraging consumers to drop cable andsatellite TV services, one of their chief sources of revenue.

Hulu's management, on the other hand, contends that the current
strategy of reaching the widest possible audience on the free site
will ultimately generate higher advertising revenue. They say
revenue is expected to top $500 million this year, proof that its
current emphasis is paying off.

In a short time, Hulu has exploded into one of the top Internet
video destinations, defying skeptics who predicted that a service
backed by such an unwieldy joint venture would never work. It now
attracts some 27 million users every month, according to ComScore
Video Metrix.

Jason Kilar, a former top executive at Amazon.com Inc. who wasrecruited to be CEO of Hulu because of his Internet know-how, hasbeen chafing under the old-media company owners. He has proposed arestructuring that would give him greater autonomy, according topeople familiar with the situation, who were not authorized tospeak publicly about it.

According to these people, Kilar has been resisting efforts by
Hulu's owners to institute fundamental changes, such as squeezing
in additional commercials. A large part of Hulu's appeal has been
its modest reliance upon commercials ---- only 3 1/2 minutes in a
half-hour prime-time show, compared with eight minutes on TV.
Advertisers like the lighter load because it makes their messages
stand out. In the first quarter, Hulu attracted 289 advertisers, up
about 50 percent from a year earlier.

The crux of the problem is that Hulu's ad sales are still
dwarfed by some $30 billion annually in programming fees that pours
into the media giants from cable, satellite and telecom providers.
Those fees support the cost of producing content, and undercutting
them by steering viewers away from TV and to the Internet would
jeopardize the sturdiest financial leg of the TV industry.

Despite Hulu's ad surge, it's not enough to satisfy its media
owners. The three entertainment companies each received less than
$100 million in revenue from the service last year.

The issue, said Chris Allen, director of video innovation for adagency Starcom, is whether Hulu is "generating enough revenue tomake it a sustainable model."

To boost revenue and in a bid to capture the iPad and portabledevice market, Hulu began encouraging people last year to sign upfor the $7.99-a-month subscription service Hulu Plus. The companyrecently said it was "on pace" to reach 1 million subscribers bythe end of the year.

The media company owners, in another move to keep viewers
choosing TV over the Internet for watching shows, have proposed
delaying the availability of free episodes. At present, users can
go to Hulu to watch episodes that aired the previous night on TV.
But viewers may eventually have to wait weeks after the network
airing to see the episode on Hulu.

Another decision looms. This summer, Hulu's exclusive rights to
distribute ABC, Fox and NBC programming online begin to expire. The
media companies have been dragging their feet on renewals until
they resolve the questions surrounding the next iteration of
Hulu.

Tensions between Kilar and key Hulu board members spilled overin February when Kilar laid out his vision for the future in alengthy blog post. One entertainment industry veteran dubbed themissive Kilar's "Jerry Maguire letter," referring to the fictionalsports agent played by Tom Cruise whose memo called on colleaguesto stop being greedy and consider the welfare of clients.

"History has shown that incumbents tend to fight trends that
challenge established ways and, in the process, lose focus on what
matters most: customers," Kilar wrote. "Hulu is not burdened by
that legacy."

The memo blindsided Hulu's directors, including Disney CEORobert Iger and News Corp. President Chase Carey. People close tothe executives said they were displeased about being taken to taskso publicly.

Kilar, Iger and Carey declined to comment.

Much has changed since Hulu launched in 2008. The two executiveswho hired Kilar ---- former News Corp. President Peter Chernin andformer NBC Universal CEO Jeff Zucker ---- have exited theircompanies, leaving Kilar without his influential advocates. NBCUniversal has also been sidelined, forced to give up its votingrights in Hulu as a condition imposed by the government when itapproved cable giant Comcast's takeover of NBC.

The recession also intervened by forcing advertisers to pull
back, sending the networks scurrying to find new sources of
revenue. The networks didn't have to go far: They began demanding
that cable and satellite TV operators pay fees to carry the
broadcast programming they previously were getting for free. Giving
away those same shows for free on Hulu created a double
standard.

Currently, ABC, Fox and NBC provide their shows to Hulu in
exchange for 70 percent of the advertising, forgoing a cash fee for
carriage. The media companies have discussed levying a programming
fee on Hulu just as they do with cable operators.

"The rights given to Hulu were intended to be a head start, to
get them on their feet," said one executive with knowledge of the
situation, who was not authorized to speak on the record. "Now, the
content owners feel that it's time to take the training wheels off
and start to compete on another level."

The Hulu board has considered raising money to pay for more
content, including original productions. But plans for an initial
public offering were scuttled last fall because none of the owners
were ready to cede control.

The disagreements suggest the site is in limbo.

"Jason Kilar has been trying to telegraph to the investmentcommunity that this pause in their business is not going to sinktheir business," Forrester Research analyst James McQuivey said."But the delays could become fatal if the owners let things stallfor another year or so. You can only keep people motivated for solong. Talented people will find another pasture to graze in."